Emerging Markets Still Face The "Same Ugly Arithmetic"

While Emerging Market debt has recovered somewhat from the January turmoil, EM FX remains under significant pressure, and as Michael Pettis notes in a recent note, any rebound will face the same ugly arithmetic. Ordinary households in too many countries have seen their share of total GDP plunge. Until it rebounds, the global imbalances will only remain in place, and without a global New Deal, the only alternative to weak demand will be soaring debt. Add to this continued political uncertainty, not just in the developing world but also in peripheral Europe, and it is clear that we should expect developing country woes only to get worse over the next two to three years.

Nothing fundamental has changed. Demand is weak because the global economy suffers from excessively strong structural tendencies to force up global savings, or, which is the same thing, to force down global consumption. Lower future consumption makes investment today less profitable, so that consumption and investment, which together comprise total demand, are likely to stagnate for many more years.

Squeezing out median households

Two processes bear most of the blame for weak demand.

First, because the rich consume less of their income than do the poor, rising income inequality in countries like the US – and indeed in much of the world – automatically force up savings rates.

Second, policies that forced down the household income share of GDP, most noticeably in countries like China and Germany, had the unintended consequence of also forcing down the household consumption share of GDP. This income imbalance automatically forced up savings rates in these countries to unprecedented levels.

For many years the excess savings of the rich and of countries with income imbalances, in the form of capital exports in the latter case, funded a consumption binge among the global middle classes, especially in the US and peripheral Europe, letting us pretend that there was not a problem of excess savings. The 2007-08 crisis, however, put an end to what was anyway an unsustainable process.

It is worth remembering that a structural tendency to force up the savings rate can be temporarily sidestepped by a credit-fueled consumption binge or by a surge in non-productive investment, both of which happened around the world in the past decade and more, but ultimately neither is sustainable. As I will show in my next blog entry in two weeks, in a closed economy, and the world is a closed economy, there are only two sustainable consequences of forcing up the savings rate. Either there must be a commensurate increase in productive investment, or there must be a rise in global unemployment.

These are the two paths the world faces today. As the developing world cuts back on wasted investment spending, the world’s excess manufacturing capacity and weak consumption growth means that the only way to increase productive investment is for countries that are seriously underinvested in infrastructure – most obviously the US but also India and other countries that have neglected domestic investment – to embark on a global New Deal.

Otherwise the world has no choice but to accept high unemployment for many more years until countries like the US redistribute income downwards and countries like China increase the household share of GDP, neither of which is likely to be politically easy. But until ordinary households around the world regain the share of global GDP that they lost in the past two decades, the world will continue to face the same choices: an unsustainable increase in debt, an increase in productive investment, or higher global unemployment, that latter of which will be distributed through trade conflict.

Emerging markets may well rebound strongly in the coming months, but any rebound will face the same ugly arithmetic. Ordinary households in too many countries have seen their share of total GDP plunge. Until it rebounds, the global imbalances will only remain in place, and without a global New Deal, the only alternative to weak demand will be soaring debt. Add to this continued political uncertainty, not just in the developing world but also in peripheral Europe, and it is clear that we should expect developing country woes only to get worse over the next two to three years.

Michael Pettis apparently is very respected as a China commentator, he also lives there. Most of what I have seen (limited, and via Mish's blog) seems to be spot-on.

I will be in Peru very soon for a little while. I will report back as to how they are doing. A guy I know who works for Sundyne (capital equipment like pumps for chemical plants & refineries) says that only Colombia & Peru are doing well in LatAm.

I would not be in a position to say re LatAm as a whole, but can report back re Peru (although when I was in Costa Rica about a month ago, they told me THEIR economy was weak too).

Did ZeroHedge just post a pro-Keynesian article? As I read this, the author is calling for a modern day "New Deal" to offset the excess savings rate. Without it, unemployment will remain too high. That's the core of this article.

Great article, by the way. I completely agree. We need QE for the people, not the bankers. All that QE money went straight into the financial markets, which, in turn, filled the pockets of the plutocrats and the coffers of corporate profits.

That thing can be "closed" simply by having a major clash of arms on the Black Sea.
"The Sultan need not do anything more but watch."

This unprovoked attack on Ukraine has an eerie "programatical" feel to it...almost like it was "contrived." My first instinct is to say the Russians walked into a trap...and my second instinct is to say they cannot get out of it now as well and "everyone else has just followed the order flow." That could include the President of the United States I might add.

So...no, not only does "math" still exist, but in many ways it matters now more than ever. "We all might need to find the off ramp here" shortly.

You heard it here first on ZH, "it is clear that we should expect developing country woes only to get worse over the next two to three years." That means BUY stocks in develping countries. ZH hasn't been on the right side of a trade yet.

Imo non-western players don't grasp the cost to the global economy of western banking cartels.

The stupendous risk cost has been demonstrated. I've heard estimates of 11 to 24 trillion in loans by the Fed to stem the financial crisis. But maintenance and opportunity costs? Given the nature of bank balance sheets, mark to model, and well they're called TBTF for a reason it's impossible to do anything but WAG.

I wonder if they really understand the currency manipulation game. There can be only one "real" winner, the dollar. Others can play and even achieve goals but only at a significant cost.